Chinese Company Offers To Acquire Control Of A Leading U.S. Battery Maker

With annual sales of approximately 19 million vehicles, China’s auto industry is now, by far, the largest in the world. Not content to be the world’s volume leader, though, government and industry leaders now share a common objective: “To make China’s auto industry the innovation leader by 2020.” To underscore this objective, Clean Energy Vehicles is one of the seven “Priority Industries” named in China’s 12th Five Year Plan that began in 2011.

Last week, Wanxiang Group Corp., one of China’s largest parts makers, offered a $450 million rescue package to A123 Systems, Inc. (NASDAQ:AONE), a U.S. manufacturer of advanced batteries for electric vehicles, and in so doing, moved China one step closer to achieving its objective. Founded in 1969 as a small bicycle repair shop by Chairman Lu Guanqiu, 67, privately-held Wanxiang has grown to be China’s largest auto parts manufacturer and one of the top 500 enterprises in the country. Chairman Lu was born into a family of farmers in Hangzhou and is representative of the many Chinese entrepreneurs who have built great companies outside China’s state-owned sector.

Wanxiang is no stranger to overseas markets. In the automotive parts industry, the company is a reliable supplier of universal joints, bearings and constant-velocity joints to customers in more than 40 countries around the world. Over the past decade, Wanxiang has been very active buying depressed American auto parts suppliers. Some of the company’s more notable transactions have included an Illinois axle maker and parts operations from Dana Holding Corporation (NYSE:DAN) and Ford Motor Co. (NYSE:F). Wanxiang’s U.S. operations, based in Elgin, Illinois, are managed by a son-in-law of the company’s founder.

According to the terms of the deal, which was announced on August 8, A123 said that Wanxiang would provide as much as $75 million in debt financing. According to the A123 statement, Wanxiang may also buy $200 million of senior secured convertible notes and invest $175 million by exercising warrants, which could be converted for shares representing a stake of about 80 percent.

While some lawmakers have raised security concerns about the deal, saying that it will transfer valuable U.S. taxpayer funded intellectual property to a foreign adversary, the fact is that A123 is a company that is running out of cash, and out of time. Other than Wanxiang, there do not appear to be any other alternatives in sight.

Despite receiving $249 million in U.S. government grants to develop its lithium iron phosphate batteries, A123 has been hemorrhaging cash. A123 has never been profitable, and since inception, has lost a total of $690 million. Moreover, losses are accelerating. The company lost $257.7 million in 2011, compared to $152.6 million in 2010 and $85.8 million in 2009. On the same day that the deal was announced, A123 said that it had lost $208 million in the first half of this year. Not surprisingly, A123’s stock has declined by 97 percent from over $25 in September 2009, to $0.57 today.

The proposed Wanxiang deal for A123 is important for what it says about the electric vehicle industry generally, and the state of the industry in the United States and China, respectively.

Before electric vehicles become staples in any country’s transportation fleet, there are very serious challenges to overcome. At their current cost, electric vehicles are not competitive without significant government subsidies. Battery technology is still very much in flux, and widespread usage of electric vehicles will require significant investments for charging infrastructure. In the meantime, the competitive landscape keeps shifting as alternative fuel sources, such as natural gas, keep popping up.

All of these obstacles can be overcome with enough capital, but that raises the question of who will supply the capital. While companies like A123 have been able to raise significant amounts of equity in the stock market when investor sentiment is high, relying upon the whims of the marketplace is not a good financial strategy, particularly when a company does not have a clear path to profitability. In this context, taking on debt to finance operating losses is not a viable option. Similarly, intermittent injections of capital by the government into companies with unprofitable business models is not an answer and only prolongs the agony.

Perhaps the most significant aspect of the Wanxiang deal for taking control of A123 is not that Wanxiang is a Chinese company, but that Wanxiang is a private Chinese company, not one of the country’s large state-owned enterprises (SOEs). If it were an SOE, it could be argued that the Chinese government is picking up the tab for acquiring A123’s technology, which would say little about the economic potential for electric vehicles in China.

However, Wanxiang is a private company, and Chairman Lu has proven himself to be a very successful and savvy entrepreneur, not only in China but also around the world, over the past forty years. While the Chinese government may be applauding Wanxiang’s announcement, he is doing the deal because he sees a real economic opportunity, quite apart from any direct or indirect support Wanxiang may receive from the government. Perhaps China’s government and industry leaders have found an effective way to work together to tackle a very difficult problem?

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